When a mysterious private equity suitor came knocking on David Jones’s door in June, all eyes went straight to the retailer’s portfolio of department stores in Sydney and Melbourne.

Those marble-floored halls of consumerism sitting on prime real estate in the heart of Australia’s two biggest cities are where the real value lies in a company struggling with weak sales and rising costs.

While the takeover interest from UK-based EB Private Equity turned out to be an embarrassing hoax, it prompted the company to take a good look at the value of its real estate.

After months of speculation,
David Jones
was yesterday able to put a potential price tag of $612 million on its four flagship properties.

Property consultant Cushman & Wakefield’s valuation is based on an assumed net rental of $39 million per annum for all four buildings. This amount could be higher if the buildings were subject to further development.

That is almost half David Jones’ current market capitalisation and says a lot about the value of a business trying to survive in an industry undergoing huge structural change when consumer sentiment is at a low point.

David Jones chief executive
Paul Zahra
made it clear yesterday that the retailer has no intention of selling the properties and leasing them back in the same way that Myer has done.

That is not the end-game for the company, which plans to spend the next six months assessing its options for the property portfolio.

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What it does do is crystalise the value of the group for the private equity firms, property developers and other potential bidders waiting in the wings.

While David Jones has not received any approaches since the UK-based EB Private Equity farce three months ago, the retailer is expected to field inquiries in coming months now that it has quantified the value of the assets.

The problem for potential suitors and the investment banks and real estate firms hoping to work for them previously has been the difficulty in quantifying the value of the stores.

Analyst forecasts have ranged from $500 million to $1 billion. UBS recently estimated the market value of the properties at $666 million using the valuation of Myer’s Melbourne CBD store as a proxy.

David Jones owns two flagship stores in Melbourne’s Bourke St and two prestige blocks in Sydney’s Elizabeth and Market streets.

The stores, which have 85,863 square metres of floor space, are at the heart of bricks and mortar CBD retailing in Australia which had a resurgence more than a decade ago as inner-city living revived and big global brands arrived.

Cushman & Wakefield’s estimated annual rent translates into an investment return of 6.4 per cent for the properties, which some analysts said looked high compared with Westfield Sydney City at 5.1 per cent.

David Jones wouldn’t put it this way but it has effectively tarted itself up for a potential suitor.

The company says the aim of the exercise is to unlock potential value from the properties, while addressing the speculation about their value in recent months.

The question is what does it want to do with them now?

While times are tough, David Jones is not about to transform into a property developer, but over the next six months it will look at a range of options such as adding new floors or partially leasing the space to other tenants. It could do this by working with an external property developer.

UBS estimates David Jones could add $47 million in value by adding 39,000 sq m of space above the sites. It could also look at a partial sale or a partial lease of the stores.

David Jones says it does not necessarily want to do this, though.

The Sydney CBD location alone makes up 25 per cent of its total volume and consolidating two stores into one is not an option, it says.

Any development potential could also be constrained by heritage restrictions on the Sydney stores and height restrictions in Melbourne.

But there is the potential to add floors of residential or office space.

While some investors would like nothing better than for David Jones to sell all four properties and return the proceeds to shareholders, that is not the plan for now.

The downside in selling its most valuable asset would be the savings it makes as owner-occupier and potential capital gains tax implications.

It would not be the first time the retailer has looked at offloading its real estate. In 2000, it sold a ground lease of its Sydney and Melbourne properties for $366 million but bought it back in 2006 for $415 million.

It is hard to shake the feeling that a review of the property portfolio is another step towards the death of the department store, something the company denies.

David Jones yesterday reported a nearly 40 per cent drop in full-year profit to $101 million. This was partly due to the cost of clearing excess inventory and much-needed investment to improve service.

While the result was in line with previous guidance, it is a stark reminder of the challenge the retailer faces. Falling sales, rising costs and an uncertain macro-economic environment do not bode well for the year.

While there has been an improvement in trading into the current quarter, the second quarter which includes Christmas is the most important.

David Jones decided not to provide earnings guidance after Myer and other retailers decided to do the same in recent weeks.

Zahra said yesterday the strategy remained unchanged. A key focus is on developing the retailer’s “omni-channel" offering which is coming to market years too late and will struggle to compete with superior offshore offerings.

The different world that old-style retailers like David Jones find themselves caught up in was highlighted yesterday in a results presentation in Madrid by Spanish retailer Inditex.

Australian shoppers are more familiar with Inditex as the owner of the successful Zara brand which opened in Sydney earlier this year.

While retailers globally are in the doldrums, Inditex’s first-half net profit rose by a third, according to Reuters.

The secret appears to be an ability to exploit a trend called “fast fashion" which fast-tracks clothes from the catwalk into stores. Other offshore brands like Topshop are hosting online fashion shows, allowing shoppers to buy items they see on models immediately online.

That is the kind of competition David Jones and Myer are up against.

Reviewing property also marks a significant shift in strategy under Zahra, whose predecessor Mark McInnes was keen to hold on to the landmark properties.

The real trigger for going down this path is not entirely clear although the theory that it will attract a bidder for the company is the one gaining the most traction.

Zahra laughed nervously when asked about the EB Private Equity bid yesterday. And so he should.

For those who do not remember, EB Private Equity was the name of an entity created by UK-based John Edgar who pulled the wool over David Jones board’s eyes with a $1.65 billion takeover offer that turned out to be a fake.

David Jones said yesterday that an Australian Securities and Investments Commission investigation into the offer, which sparked a rally in the company’s share price, was over. It is understood there was never a substantial investigation, at least not one with a capital “I" in the first place.

Unlocking the value of the flagship stores, however, could be the catalyst for a more genuine offer.

The fact that the market and the David Jones board was so quick to take the EB Private Equity offer seriously highlights the expectation that predators are out there.

If not, the coveted beauty counters and food halls of the 170-year-old department store group could soon be more valuable as the foyers for a high-rise apartment block.